| Abstract: |
During the period 1991-93, Finland experienced the deepest economic downturn
in an industrialized country since the 1930s. We argue that the culprit behind
this Great Depression was the collapse of Finnish trade with the Soviet Union,
because it induced a costly restructuring of the manufacturing sector and a
sudden, large increase in the cost of energy. We develop and calibrate a
multi-sector dynamic general equilibrium model with labor market frictions,
and show that the collapse of Soviet-Finnish trade can explain key features of
Finland’s Great Depression. We also show that Finland’s Great Depression
mirrors the macroeconomic dynamics of the transition economies of Eastern
Europe. These economies experienced a similar trade collapse. However, as a
western democracy with developed capital markets and institutions, Finland
faced none of the large institutional adjustments that other transition
economies experienced. Thus, by studying the Finnish experience we isolate the
adjustment costs due solely to the collapse of Soviet trade. |